ESG and Carbon Markets - The Key to a Low-Carbon Economy

Presentation 4_Jin Ick_National Assembly Budget Office_ESG and Carbon Markets - The Key to a Low-Carbon Economy.pdf

1. ESG and Carbon Markets:
The Key to a Low-Carbon Economy
[Side Event in COP28 Korean Pavilion]
Leveraging Data for Transparency and Efficiency in Voluntary and Compliance Carbon Markets
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2023. 12. 04
Ick Jin, PhD/CFA/CIPM
Director General of Economic Analysis Department
National Assembly Budget Office

2. Contents
Goals
Challenges
2
Countermeasures
Suggestions

3. Goals
☞The goal of low carbon green growth strategy(Framework Act)
•Reducing carbon emission & Securing new growth engines
☞Carbon market … market-based policy instrument
•Compliance market & Voluntary market
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Voluntary marketCompliance market ESG investingRegulation
Market
Discipline
☞ESG investing … market discipline to internalize externalities
•Improving ESG values & Enhancing risk-adjusted returns

4. Contents
Goals
Challenges
4
Countermeasures
Suggestions

5. Challenges: Projected pathway
☞Risk of predicted emissions pathways falling short of NDC target pathways
•The Korean NDC target is challenging given the projected state of the economy. (Jin 2023a)
•The planned energy transition (Path[B]) can raise the fulfilling probability. (Jin 2023c)
Probability of meeting the NDC targetPredicted pathway vs. NDC target pathway
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Source: Jin (2023b) Source: Jin (2023c)

6. ☞Required changes in the energy mix and carbon price to meet NDC goals
•Both production and energy consumption would be curtailed while achieving the NDC target.
•The degree of contraction can be mitigated with the change in energy mix. (Jin, 2024)
Challenges: Closing implementation gaps
Change in
carbon price
Change in
energy mix
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carbon price energy mix
Source: Jin (2024) Source: Jin (2024)

7. Challenges:Stagnant carbon market
☞Carbon markets are not as active as they could be.
•The gently sloping demand curve is crossing the supply curve at a low point.
•Changes in preferences, systematic risk, etc. can cause the demand curve to shift.
☞Mispricing of systematic carbon risk
Price
S
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☞Mispricing of systematic carbon risk
•“ESG investing” = “conventional investing”
+ “downside protection” (Jin 2018)
•Tradable downside protection
☞Incorporating the ESG downside protection
would result in a different optimal portfolio.
•Improved performance (Jin 2022a)
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8. Contents
Goals
Challenges
8
Countermeasures
Suggestions

9. Countermeasures: Balanced scaling up
☞Creating a virtuous cycle
☞Some possibilities for ESG investors to participate in both sides of carbon markets
•[Demand] Utilizing carbon credits as a means of managing systematic carbon risk
•[Supply] Engaging in offset business as an alternative source of revenue … diversification
Price
S
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☞Creating a virtuous cycle
•Enabling secondary markets
•Increased trading volume … liquidity
•Reasonable market price appreciation
•Additional supply and demand
•More active secondary markets
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Quantity
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10. Countermeasures: Alignment with ESG investing
☞Potential linkages
between carbon
markets and ESG
investing
•The majority of ESG
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Source: OECD
investors want to
enhance risk-
adjusted returns.
•Can carbon markets
provide what they
want?

11. Countermeasures: Attracting ESG investors
Performance based on ESG screening level
☞Creating a market environment that encourages ESG investor participation
•ESG investors are looking for ways to manage carbon risk while maintaining diversification.
•Once a few hurdles are cleared, carbon markets would become attractive to ESG investors.
[Objective]: Lowering entry barriers …
financial instruments for speculative investors
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Source: Jin (2022b)
financial instruments for speculative investors
[Principle]: Sharing risk …
platform for screening and monitoring
[E&S]: Internalizing externality …
measurement, reporting, and verification
[G]: Mitigating agent-principal problem …
disclosure, information production, etc.

12. Contents
Goals
Challenges
12
Countermeasures
Suggestions

13. Suggestions: Incorporating lock-in effect
Outcome
☞Designing sophisticated policy to stimulate carbon markets under lock-in effect
•Short-term transition costs can make market participants reluctant to switch to a new path.
•The effectiveness of the initial intervention can determine the success of the transition.
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Long-term Time
Outcome
Transition
latency
With carbon markets
Without carbon markets
Short-term

14. Suggestions: Refining a safety net
Public
Safety-net
Systematic
Risk
Catastrophic
Risk
Individual
Risk
Private
Safety-net
Screening
Monitoring
Climate
Project
☞Building a multi-
layered safety net
based on risk type
•Private ESG investors to
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Developing
Risk Managing
Funding
Government
(“CCA”)
Carbon
Markets
(CCM, VCM)
Guarantors
VC, PEF
CB, IB
•Private ESG investors to
handle individual risks
•Carbon markets to
manage systematic risk
•Government to take
catastrophic risk as a
last resort
Source: Jin (2022), revised

15. Suggestions: Securing policy instruments
☞Gaining policy levers to manage the total amount and price of emission allowances
•“Reference price”to influence the market price of carbon risk remotely
•"Carbon central authority" to balance demand and supply in response to economic conditions
Financial asset Carbon asset
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Reference rate
Treasury rate
Corporate bond rate
Investment return
Penalty (Carbon tax)
Compliance market price
Voluntary market price
Financial asset Carbon asset
Policy
Instrument
Decision
Driver
Linkages
between
markets
Arbitrage
Mobilizing
private
capital

16. Reference
Boffo, R., and R. Patalano(2020), “ESG Investing: Practices, Progress and Challenges”, OECD Paris, www.oecd.org/finance/ESG-Investing-Practices-
Progress-and-Challenges.pdf
Jin, Ick. 2018. “Is ESG a systematic risk factor for US equity mutual funds?” Journal of Sustainable Finance & Investment, 8:1, 72-93, DOI:
10.1080/20430795.2017.1395251.
Jin, Ick. 2020. “Challenge of achieving sustainable growth in response to changes in economic structure” Structural Changes of the Korean Economy
and Response Strategies. NABO. [in Korean]
Jin, Ick. 2022a. “Systematic ESG Risk and Decision Criteria for Optimal Portfolio Selection.” The Journal of Portfolio Management 48 (10): 206–25. htt
ps://doi.org/10.3905/jpm.2022.1.418..
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ps://doi.org/10.3905/jpm.2022.1.418..
Jin, Ick. 2022b. “ESG-screening and factor-risk-adjusted performance: the concentration level of screening does matter,” Journal of Sustainable Finance
& Investment 12 (4), DOI:10.1080/20430795.2020.1837501.
Jin, Ick. 2023a. “Probability of Achieving NDC and Implications for Climate Policy: CO-STIRPAT Approach”. Journal of Economic Analysis 2 (4):82-97.
https://doi.org/10.58567/jea02040005.
Jin, Ick. 2023b. “Outlook for the growth rate of GHG emission”. Economic Outlook for 2024 and the Medium-Term. NABO. [in Korean]
Jin, Ick. 2023c. “Emission prediction, Global Stocktake, and NDC update: CO-STIRPAT dynamic system (November 23, 2023). Available at SSRN:
http://dx.doi.org/10.2139/ssrn.4626420.
Jin, Ick. 2024. "An Operational Framework for a Low-carbon, Green Growth Economy: CO-STIRPAT Dynamic System“. Journal of Economic Analysis 3,
no.4: 79. https://doi.org/10.58567/jea03040005..

17. Thank you for attention!
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Ick Jin, PhD/CFA/CIPM
Director General of Economic Analysis Department
National Assembly Budget Office